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Eyeing A Tax On Company Benefits

December 11, 2005

With much of his 2005 domestic agenda in the deep freeze, President Bush is in the market for big ideas. And BusinessWeek has learned that Bush is seriously considering one that could lead to profound changes in the way businesses provide health insurance for their employees. The plan would, for the first time, curb the generous tax breaks that employees get with their company-paid medical coverage. It's a sweeping move that could affect almost every business and give the President a bold, if controversial, reform initiative for his State of the Union address in January.

Bush sees a cap on the health-care tax subsidies as one way to rein in soaring medical costs, give people more control over their insurance, and generate new revenues. And many experts like the idea. But messing with employer-sponsored care runs a huge political risk. Mere talk of such an option is already uniting business and labor in opposition. "Let's call it what it is: a proposal to tax benefits," says a lobbyist for the U.S. Chamber of Commerce. Unions are preparing to paint any such plan as "Son of Social Security Reform," another assault on the safety net.

Currently, two-thirds of Americans under 65 get health coverage on the job. Employers pay more than 70% of the cost of those policies, and thanks to Uncle Sam, workers get the benefit tax-free. That will save insured employees a staggering $126 billion in taxes this year.

In an effort to change that, Administration aides are looking closely at a proposal that didn't receive much attention when Bush's tax reform commission suggested it in early November. The idea: If workers receive high-cost health insurance paid by their employer, they should be taxed on part of the value of those benefits. Curbing tax breaks is "a sensible start," says Massachusetts Institute of Technology economist Jonathan Gruber. "And it won't take that long before it actually starts to have some bite."

Today the average family policy costs about $10,800. Under the plan being eyed by the Administration, employees could still get $11,500 in family coverage tax-free. But if their insurance is more generous, they would have to pay taxes on the difference. That could add several hundred dollars to the taxes of high-end executives and union members with generous health packages, such as teachers, firefighters, and police.

Backers of the idea say that taxpayers shouldn't subsidize gold-plated policies. They argue that patients with such Cadillac plans have little incentive to shop for efficient care, buy generic drugs, or question whether they need yet another expensive test.

What's more, the benefits of such tax breaks are overwhelmingly tilted toward wealthier workers. Because the value of deductions rises with tax brackets, high-income families get a third of their costs covered by Uncle Sam. Working-class families get only a 10% subsidy.

Even before the plan is fully hatched, corporate lobbyists have begun raising objections in meetings with Administration staffers. At the same time, companies and unions have begun to line up opposition on Capitol Hill. AFL-CIO health lobbyist Gerald M. Shea says that fighting the cap could top labor's 2006 legislative agenda.

FODDER FOR THE DEMS

Unions worry that limiting tax breaks for insurance would accelerate the loss of workers' health benefits -- already under siege as companies seek to curb soaring costs. And as much as chief executives dream of getting out of the business of offering health insurance, many large employers fear that the alternative to workplace coverage would be a big government program that they would end up paying for through higher taxes.

Bush may try to calm the business community by letting workers use pretax dollars to buy their own insurance. Indeed, the President has been talking for years about giving a tax credit to people who purchase policies on their own rather than through their job. But Bush has more will than wallet, and the tax benefits are too small to jump-start the full-blown market for individual insurance that he favors.

With business and labor opposed, any proposal will face a tough fight on Capitol Hill. Republicans already worry that an unpopular President could cost them control of Congress in 2006. Now, they fear, the health plan could fuel Democratic demagoguery along these lines: "Last year, he tried to take your Social Security. This year, he's after your health care." But that might not stop a President known for rolling the political dice from pushing a plan he believes is good public policy.